Earnings Call Transcript - ETD Q3 2022

Operator, Operator

Good afternoon and welcome to the Ethan Allen Fiscal 2022 Third Quarter Analyst Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. Please note this conference is being recorded. It is now my pleasure to introduce your host, Matt McNulty, Senior Vice President, CFO and Treasurer. Thank you. You may begin.

Matt McNulty, CFO

Thank you, Paul. Good afternoon. And welcome to Ethan Allen's analyst conference call for our fiscal 2020 third quarter ended March 31. Joining me today is Farooq Kathwari, our Chairman, President, and CEO. Mr. Kathwari will open and close our prepared remarks, while I will speak to the financials midway through. After our prepared remarks, we will then open the call for your questions. Before we begin, I'd like to remind the audience that this call is being transcribed and recorded live on ethanallen.com, where you will find a copy of our press release, which contains reconciliations of non-GAAP financial measures referred to in the release and on this call. A replay of today's call will also be made available via phone and on our website. As a reminder, our comments today will include forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ materially. Please refer to our SEC filings for a complete review of those risks. The company assumes no obligation to update or revise any forward-looking matters discussed during this call. With that, I'm pleased to now turn the call over to Mr. Kathwari.

Farooq Kathwari, CEO

Thank you. And thank you for all your support in our third quarter earnings review call. We continue to make good progress in many areas, resulting in strong financial results for the quarter ended March 31, 2022. Sales of $197.7 million increased 11.7% from the previous year quarter. Strong gross margins of 60.4% compared to 57.3% in the previous year quarter. Control over our operating expenses resulted in adjusted operating income of $31.3 million, a 59.9% increase. Our adjusted EPS of $0.93 increased 60.3% from the previous year quarter. After Matt McNulty provides a brief overview of our financial areas of focus, I will conclude the remarks. And with that, Matt, please take over.

Matt McNulty, CFO

Great. Thank you again. Consolidated net sales increased 11.7% as a result of strong demand and increased levels of manufacturing production that led to higher deliveries, combined with the prior year being negatively impacted by COVID-19. The increased production was partially offset by ongoing supply chain disruptions, which negatively impacted imports and raw material availability. As the third quarter progressed, we saw an increase in the receipt of product from a higher volume of shipping container receipts. Our retail orders were down 3% compared to a very strong prior year comparable; however, retail orders were up 18.2% compared to our pre-pandemic fiscal 2019 third quarter. Wholesale segment orders were down 0.2% from last year, but were up 8.4% compared to the third quarter of 2019. The higher level of product demand that we continue to experience has also led to an increase in our backlog, despite the fact that our manufacturing production levels have returned to pre-pandemic levels. Delivery lead times remain higher than historical averages, as the first half of our third quarter was marked with higher COVID-19 absenteeism among our employee base, raw material constraints, and supply chain disruptions. However, March had strong production and related deliveries that enabled us to decrease backlog during that month. With that said, our order backlogs remain high and at March 31st were approximately 25% higher than a year ago. Consolidated gross margin increased 310 basis points to 60.4%, primarily due to a change in sales mix, higher manufacturing productivity, previous product pricing actions that are beginning to work their way through our P&L and a favorable product mix, partially offset by higher import and raw material costs. The retail sales mix grew to 84% of consolidated sales compared with 79.9% a year ago. While we were pleased with our consolidated gross margin of 60.4%, we expect our margin to return to approximately 58% in the near term due to the impact of input costs and a return of sales mix to more historical norms. Our operating margin increased from 10.7% last year to 16.5% in the current year's third quarter. Adjusted operating margin was 15.8% of sales, up from 11.1% of sales last year due to fixed cost leverage on the higher sales volume, strong retail gross margins, and cost containment measures, including lower marketing costs due to a change in marketing initiatives as will be discussed by Mr. Kathwari shortly. Now, turning to our liquidity and capital resources. We ended the third quarter with a strong balance sheet, including cash and investments of $104.6 million and no debt. We generated $17.3 million of cash from operating activities in the quarter due to strong net income and increased customer deposits, partially offset by additional purchases of inventory to support increased production as well as to help protect against future supply chain disruptions and price increases. Capital expenditures were $5.3 million and primarily related to the expansion of our upholstery manufacturing in North Carolina, the construction of two new retail design centers, spending on design centers, projection improvements, manufacturing plan upgrades to further increase capacity and efficiency, and investments in technology. Reflecting the strength of our balance sheet and strong history of returning capital to shareholders, our Board declared a regular quarterly cash dividend of $0.29 per share in January, which was subsequently paid in February, bringing the total year-to-date dividends paid to $40.1 million. Also, as just announced this past Tuesday, our Board increased the regular quarterly cash dividend by 10% to $0.32 per share, which will be paid in May. Lastly, as mentioned on our January earnings call, we amended our existing credit agreement to provide us with a revolving credit line of $125 million and extend the maturity of the facility to January 2027. The amended agreement also provides us with the transition of SOFR, improved product pricing on borrowings, and enhanced future flexibility over the next five years. With that, I will turn the call back over to Mr. Kathwari.

Farooq Kathwari, CEO

All right, Matt. And I would just like to tell everybody that I was coming from New York to Washington, and my plane got delayed. I arrived at this office where I'm speaking from just at 4:59. So, one minute before this call. Things worked out. So, I'm actually speaking from my mobile phone and covering a lot of important areas today. Now, our focus during the quarter continued on our key areas that will help us to continue the progress. The first area is talent. The development of strong talent continues to be an important area of focus in our vertically integrated enterprise. We promoted a number of key associates, including within our retail division and business development, product development, marketing, manufacturing, finance, technology, operations, and logistics. I am very pleased that we have a strong team in place. The second area of focus is service. Improving our capabilities to increase production has been key to improving our service and shipments. About 75% of our products are made in our North American workshops and almost all are made custom when orders are received. This requires effective management of inventories and parts to help manufacture in a timely manner. We continue to greatly improve our delivery time. Our customer upholstery products made in our North American workshops ship in seven to nine weeks, compared to 15 to 17 weeks six months back. We are also making good progress in improving shipping times in our wood products made in our North American workshops, now averaging about 10 to 12 weeks, compared to 14 to 16 weeks. Continued investment in our workforce and technology in our North American workshops have been key to increased production and efficiency. We acquired a new 50,000 square foot upholstery manufacturing operation in Clarendon, North Carolina, and continue to consolidate technology and operations in our recent 80,000 square foot addition to our main North Carolina upholstery operations. We also continue to invest in technology in our Vermont, Mexico, and Honduras manufacturing workshops. We are pleased that we have invested a significant amount over the years in our manufacturing and logistics. Just to give you a perspective, in our case goods, we have close to 1.3 million square feet of manufacturing space, and we own all of it. In upholstery, also close to 1 million square feet. In logistics, we have 1.2 million square feet. All of this has really given us a great opportunity to improve our business model. In our marketing, our focus is to continue reaching a larger consumer base utilizing many new modes of communication, greatly increasing our reach while reducing costs. We have greatly reduced the costs of producing our advertising content, thereby further reducing expenses. Now, while we have overall reduced our cost, we have been able to maintain that most of our money has been spent in advertising through various mediums, not in producing it. Now, digital mediums have been key in our marketing efforts. During each month, we are now reaching about 20 million households through our 336-page digital mediums. During the quarter, we also ran national and regional television commercials. We also selectively utilize other mediums such as printed direct mail. Another important effort has been the grassroots work of our over 1,000 retail design associates and management, who are reaching clients via social media. We have continued to add new products as we feel comfortable with our ability to service effectively. We have a strong product program ready for launch, and as we feel comfortable with our service position, we will launch them. Another area has been a major focus on technology. Investments and initiatives in technology, in marketing, manufacturing, and logistics continue to be key in improving our ability to service our clients and increase our sales and profitability. Combining personal service of our interior designers with technology continues to be a game changer. We have maintained strong business during the last two years of COVID due to several factors, such as offering quality and value with 75% of our products made in our North American workshops, and importantly, thanks to the combination of personal service from our interior designers with technology. Continued repositioning of our retail design centers with smaller sizes and excellent locations is tremendously important, as is the use of technology in our retail. We recently opened two new design centers following this concept, one in Westport, Connecticut, and the other two weeks back in Walnut Creek, California, which is in the San Francisco area. In March 2018, in our retail division, we had about 1,900 retail associates and 900 designers. Today, we have 1,200 retail associates and close to 600 designers. So about a third less, and the return is up considerably, and the quality of our teams is making this happen. Finally, our social responsibility and safety are always a focus. Managing our enterprise in a socially responsible manner has been part of our 90 years of innovation. We continue to receive many recommendations and rewards for conducting our business in a socially responsible manner. We believe that is an essential part of our DNA. With this brief overview, I'm happy to open for any questions or comments.

Operator, Operator

Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question is from Brad Thomas with KeyBanc Capital Markets. Please proceed with your question.

Farooq Kathwari, CEO

Hello, Brad. How are you?

Bradley Thomas, Analyst

Hi. Good afternoon, Farooq. Good afternoon, Matt. And Farooq, I hope the rest of your travels are relatively uneventful. But …

Farooq Kathwari, CEO

Thanks, Brad.

Bradley Thomas, Analyst

A couple of questions if I could. First of all, Farooq, I was hoping you could talk a little bit more about the cadence of business. We've heard from some other retailers and manufacturers of home items and furniture and mattresses that things have been a little bit softer over the last month or so. I was hoping you could just comment a little bit about the pace of business and what you've been seeing as we move into April.

Farooq Kathwari, CEO

Yes, Brad. There are two factors here. The first is relative to the very strong business that we have seen in the last six months. We continued that in March. I think in April, this month—of course, it's not finished—but I think we can see that people are being cautious, and I think it was to be expected. So, I think that people are cautious, but on the other hand, they're also looking much more carefully at value—in terms of quality, pricing, and service. The good news is that we are well positioned in all those areas. While we do expect people to not have the kind of crazy behavior that happened in the last year and a half, and that business will slow down, I believe we will be able to maintain our momentum as we move forward.

Bradley Thomas, Analyst

Gotcha. That's helpful. And how would you all characterize the backlog today? I know you're having success reducing some of the delivery times as you mentioned. But I think when we look at the customer deposit numbers, it's one of the highest numbers that we've seen in company history. So, how should we think of the size of the backlog, and the opportunity for that from a revenue perspective?

Farooq Kathwari, CEO

Yeah. I think that if you take a look at our backlog, for instance, compared to our retail and wholesale backlog, it is up between 22% to 23% compared to the previous year, even after very strong deliveries. So, I think that certainly for the next few months, we will work to continue to reduce this backlog. We have already reduced the timeframe, as I mentioned, in terms of our deliveries, which is, of course, also positive because of the fact we make it. So, I think that right now, backlogs are decent, but our production has also increased. So, I think we will continue to improve our shipments and deliveries, and the backlog will most likely continue to go down, although it is at decent levels right now.

Bradley Thomas, Analyst

Great. And Matt, I think I heard you make a comment about the gross margins being in the 58% range. Did I hear you right? And were you focused on a particular quarter, or the annual level? What was the comment on gross margin?

Matt McNulty, CFO

Yeah. So, we ended this quarter Q3 at 60.4%, but we expect that with some higher raw material and freight costs continuing and uncertainty out there, we expect it to come down a little bit. We provided the number 58%, and that's in the near-term—not specific to one particular quarter, but in the near term.

Farooq Kathwari, CEO

And again, that is—Brad, it just makes certain assumptions on gross margins. Right now, 60.4% is at a record high. If you take a look at it, last year coming into our fourth quarter, our gross margins were close to, I think, 58.7%, correct, Matt?

Matt McNulty, CFO

Correct. Yeah. Yeah. Correct.

Farooq Kathwari, CEO

So, I think that what Matt is saying is that most likely between 58% and 60% is where we will end up.

Bradley Thomas, Analyst

Great. Thank you very much, Farooq and Matt.

Farooq Kathwari, CEO

All right, Brad. Thanks very much.

Operator, Operator

Thank you. Our next question comes from Cristina Fernandez with Telsey Advisory Group. Please proceed with your question.

Farooq Kathwari, CEO

Hello, Cristina.

Cristina Fernandez, Analyst

Thank you. Hi, good afternoon Farooq and Matt. I had a couple of questions as well. I wanted to start with, if you can give more color on what you're seeing as far as cost inflation versus the last time we had the call and also, the level of price increases. I think last time you said you had raised prices around 10%. Is that still the case, or are you finding that you need to raise prices more to offset cost inflation?

Farooq Kathwari, CEO

Yes. These are very important areas, Cristina. Now, we have—Matt has, I mean, I have the numbers too, but Matt, you and I were discussing the numbers. In terms of—we have a number of factors. One is, fortunately, that 75% of our products are being made in North America. These products have been less impacted than our imported products. Our imported products, Matt, correct me, but we are talking often, we have seen an increase of anywhere from 20% to 25%.

Matt McNulty, CFO

That is correct.

Farooq Kathwari, CEO

And while our domestic, I mean, our North American products, you're talking about maybe a 10% or 12% increase. And a lot of this international impact has been due to freight costs. We also deliver our products at one cost nationally, and that has also impacted the cost of transportation domestically. I'm talking about North America, from Mexico to Honduras, to our facilities and then shipping it to all our retail network. I think that also has gone up 8% to 10%. So, I think going forward, we have most likely seen the worst of the increases—certainly in transportation and overseas. We have taken price increases, I would say, averaging between 10% and 15%. As we move forward, we'll continue to look at our pricing to see what increases we may have to take, but perhaps anywhere between 5% and 10% in the next six months, possibly. And that's what we are looking at, Cristina.

Cristina Fernandez, Analyst

Okay. No, that's very helpful color. And I guess just as a follow-up. How are you reconciling the price increases that you need to take to offset cost inflation with the consumer being a little bit more cautious when it comes to pricing and values? I guess, did you expect—because we get asked a lot about promotions and promotions have been still low year-over-year. I guess, how are you thinking about your promotional tone as the year progresses?

Farooq Kathwari, CEO

Yeah. That's a good question. We have maintained approximately a 20% savings on our—what we say, everyday best price. I think that one has to be careful and concerned about the fact of what kind of price increases the consumers will accept. We have been very careful because again, 75% of our products being made in North America, where the prices really have been impacted to a great degree, have been all the offshore products, both in the cost of the product, but most importantly, in transportation. As you know, the cost of a container has gone from $2,000 to $30,000. We have not fortunately seen that domestically. So, I think you're right. We are being very cautious in our pricing while we are taking price increases. We have also been able to offer people special savings, and we'll continue to do that. We'll continue to ensure that we are competitive and keep that perspective that the consumer is not going to continue paying higher prices.

Cristina Fernandez, Analyst

Yeah, absolutely. Then, I guess another topic I wanted to discuss was on marketing. I mean, you commented about how you've been able to be more efficient with marketing. Last call, there was a number talked about getting marketing back to 3% to 4%. Is that still the target or do you think you can come below that just based on the changes you've made?

Farooq Kathwari, CEO

Well, this quarter, we—Matt, what did we spend? 3% or less, what did we spend?

Matt McNulty, CFO

2.3%.

Farooq Kathwari, CEO

2.3%. Now, there are a number of factors. Interestingly, as I mentioned in my comments, while we reduced our expenditures, we were more effective. There are a number of reasons. First is we also reduced—in our marketing, keep in mind that when we talk of 3% or 4%, it also includes all our costs of producing our marketing—that’s our advertising costs, our photo studio costs, and then also actually placing the advertising. So, our marketing costs include all of that. We have been able to, through manufacturing, reduce substantially our production costs. And we have also reduced the mediums that we are using. For instance, we spent a fair amount of money on direct mail, printed direct mail. Now in the last year or so, two years, we have been increasingly using digital mediums. For instance, we are now sending out, as I mentioned, three digital magazines. Two years back, it was—we didn't even think of it. So, the mediums are changing, plus the cost of producing is changing. Having said all of that, I think keeping anywhere around between 3% and 4% for budgeting purposes, I think is a fair thing to keep in mind.

Cristina Fernandez, Analyst

Okay. Thanks. And then, I just had one last one, and it's on the new product introductions. I noticed that you introduced flooring LVT, which is a new category for Ethan Allen and more on the home improvement side. So, can you talk about why you decided to expand into that category, or is that product you're manufacturing yourself? And just how are the new product introductions this year compared to last year?

Farooq Kathwari, CEO

Yes. I mean, we have introduced products based on availability, but also obviously on our ability to sell the products. This flooring program is a very innovative concept. It's a product that is sold by our designers. It can be used; it can be applied without needing to put in all kinds of materials. It is put together in a way that joins together as a product rather than having to be cemented or anything like that. So, a much easier way of using it. Now we have always had a strong program in carpeting, in area rugs. So, we look upon this as an addition to those programs, and it has been very well received.

Cristina Fernandez, Analyst

Okay. That's all I have. Thank you, and good luck this quarter.

Farooq Kathwari, CEO

All right, Cristina. Thanks very much.

Operator, Operator

Thank you. It looks like there are no further questions in the queue at this time. I'd like to turn the floor back over to Farooq Kathwari for any closing comments.

Farooq Kathwari, CEO

All right. Well, thanks very much. And thanks everybody for joining. I want to also thank our teams for doing a great job, and we look forward to continuing our progress and growth. So, thanks very much.

Operator, Operator

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.